Taxable Talk

This final article in the series begins with a discussion of withholding. This leads into a discussion of poker tournaments (in cardrooms and casinos). Lastly, we’ll examine banking regulations and how they impact online gambling.

The IRS is mandated with collecting the federal government’s tax revenues. For employees, this means payroll deductions of income taxes that your employers remit to the IRS. If you’re self-employed, this means filing Form 1040-ES.

Many forms of gambling have withholding requirements, while some are exempted. If you’re lucky enough to win while playing blackjack (21), baccarat, craps, roulette, or the big-6 wheel, nothing will be withheld. However, if you win $600 or more and your gross winnings are at least 300 times your wager, you will receive a W-2G and 25% of your gross winnings will be withheld. (The monetary limit is $1200 from bingo and slot machines and $1500 from Keno.)

But what about poker?

Poker is not mentioned specifically in the regulations. Thus, it falls under the generic $600 or more and 300 times your wager restrictions. There are only a few poker tournaments where this comes into play (e.g. the main event of the World Series of Poker).

The IRS isn’t happy about this. They believe, probably correctly, that many tournament poker players are not reporting all (or a large portion) of their winnings. Thus, the IRS wants to impose withholding on poker tournaments, by writing a Revenue Procedure that mandates withholding. I believe that this will likely classify poker tournaments as “wagering pools:”
26 USC [Ch. 24] Sec. 3402 (a) (1) reads,
“Every person, including the Government of the United States, a State, or a political subdivision thereof, or any instrumentalities of the foregoing, making any payment of winnings which are subject to withholding shall deduct and withhold…”
26 USC [Ch. 24] Sec. 3402 (a) (3) (C) reads,
“Sweepstakes, wagering pools, certain parimutuel pools, jai alai, and lotteries”

The IRS will try to lump poker tournaments in as wagering pools. But are poker tournaments a wagering pool? This discussion is a bit complex, so it’s in the hidden text below.

Will this stop the IRS from trying to impose withholding on poker tournaments? No, but it will be interesting to see what code section they come up with to justify withholding. Of course, if Congress amends the Code to specify withholding from tournaments, then it will become a non-issue.

Banking Regulations

Two banking rules come into play vis-a-vis online gambling. First, if you have a foreign bank account(s), and at any time during the year you have $10,000 in the account, you must report the account. You must do this in two ways: first, by checking the box on Schedule B of Form 1040 that asks this question. Additionally, you must file a report of Foreign Bank and Financial Accounts (Form TD F 90-22.1) with the US Department of the Treasury (not the IRS).

So what is a foreign bank or financial account? Bank accounts are obvious; financial accounts are less obvious. The instructions for Form TD F 90-22.1 state that the definition of a financial account is, “Generally includes any bank, securities, securities derivatives or other financial instruments accounts…The term also means any demand, checking, deposit, time deposit, or any other account maintained with a financial institution or other person engaged in the business of a financial institution.”

So now we must ask, what is a financial institution? Well, your thinking it’s a bank. But that’s not necessarily true. Under a different law (as noted below), the IRS considers the following domestic entities to be financial institutions:

“The financial institutions as defined in 31 CFR 103.11, for
which the IRS has civil enforcement are listed below.

1. currency dealer or exchanger.
2. check casher.
3. issuer of traveler’s checks, money order, or stored
value (funds or monetary value represented in digital
electronics format (whether or not specially encrypted) and
stored or capable of storage on electronic media in such a
way as to be retrievable and transferable electronically).
4. seller or redeemer of traveler’s checks, money orders
or stored value.
5. money transmitter.
6. licensed gambling casinos/card clubs having gross
annual gaming revenues in excess of $1,000,000 (except those
in Nevada where the dollar criteria is $10,000,000).
7. a domestic agent, or agency of a foreign bank which is
not supervised by one of the Federal Banking Regulations,
such as a law firm acting as an agent for a foreign bank
8. banks and other financial institutions which are not
supervised and examined for safety and soundness by any
Federal banking agency or the SEC.” (see
http://www.irs.gov/govt/tribes/article/0,,id=108265,00.html).

The IRS hasn’t pressed the point, but if they want to, they could classify all online casinos as financial institutions. There is no doubt, though, that Neteller, FirePay, and similar services are foreign bank accounts and must be reported (if you meet the $10,000 threshold).

So you have to report a foreign bank account—that’s not a big deal (just another piece of paper). Well, that’s true except for one not-so-minor detail:

The quickest and surest way that I know of to have your return audited by the IRS is to declare a foreign bank account on Schedule B and/or Form TD F 90-22.1. Based on my experience in dealing with the IRS, the audit rate is close to 100% the first time you make such a declaration.

So if you have a foreign bank account, you need to make sure you declare your gambling income.

Finally, under the Bank Secrecy Act banks are encouraged to report suspicious transactions of less than $10,000. So if you receive regular Neteller deposits of (say) $4,000 and your bank considers them suspicious, you may be flagged. The Comptroller of the Currency handles banking regulations; their handbook on the Bank Secrecy Act is available here.

Conclusion

The rules that an online gambler must follow to correctly report his or her taxes can get frustrating. The regulatory world is based on the real (brick and mortar) world, not the online world. There are many places where a gambler can make mistakes. I strongly urge that online gamblers consult a professional tax advisor to make sure that they don’t end up going down the wrong path.

In this, the fourth of five parts of my series on taxes and online gambling, I’ll examine state income taxes, withholding requirements, and some legal issues, including the Silver Platter Doctrine.

State Income Taxes

Americans not only pay federal income tax, we pay income tax to the state we live in. If you’re lucky enough to live in Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming, there is no state income tax. Additionally, New Hampshire and Tennessee tax only dividend and interest income.

Every state with a state income tax taxes gambling income. The tax rate will depend on what bracket you fall into. Unfortunately, many states do not allow deductions for gambling losses. Some of the states that don’t allow gambling losses are Connecticut, Massachusetts, and Ohio. Professionals can deduct their losses because they will file Schedule C (or the state equivalent).

And some cities have city income taxes. Some cities tax everything, including gambling; some only tax specific items (usually wages, interest, dividends, and self-employment income). As each city’s ordinance is different, you should check with a professional to determine what, if anything, is taxable and what, if anything, can be deducted.

Withholding Requirements

Adding to the filing burden is that many gamblers must make estimated tax payments. The government expects to receive its tax receipts during the year. If you’re a wage earner, a portion of your wages are withheld and paid as federal (and state) income tax. If you gamble, and you are successful, you may have to make additional estimated payments. These are done by filing Form 1040-ES. If you also have wage income, you can increase your withholding to pay your additional tax. If you elect not to make these additional payments, you may be subject to penalties for underpayment of tax (not enough tax withheld).

I strongly advise gamblers to consult with a professional tax advisor. He or she can look at your tax situation in totality, determine what payments (if any) need to be made and to whom, and give advice to your specific situation.

Deducting More Than You Lose

For the amateur, deductions are limited to the amount of winnings. This rule also holds for the professional gambler. The professional gambler is in the only profession where losses are not allowed (for tax purposes).

Personally, I believe that this violates the US Consitution’s Due Process Clause. (The “Equal Protection Clause” only applies to states, not the federal government. See this discussion.) The Tax Court, and Courts of Appeals, have ruled that the prohibition against deducting gambling losses outweighs the professional gambler’s right to be treated like any other occupation. To fight this, a gambler would have to show that he’s normally a winner, had a bad year, and win in both a Court of Appeals and potentially the US Supreme Court. That’s an expensive fight, and unlikely to happen. Thus, don’t expect any change in the law soon.

Legal Issues

I am not an attorney. The remainder of this article is not meant as legal advice. Rather, I’m examining some legal issues from a tax perspective.

I. Nelson Rose, a professor of law at Whittier University, wrote, “The State Gaming Division acknowledged that a tip from an outside source started their investigation. Jeff says he thinks it was the IRS. This is unlikely, because the IRS is bound by the “silver platter” doctrine, which prevent the IRS from turning over a gambler, and his required tax returns, on a silver platter to local law enforcement.” However, the references that I’ve seen to the Silver Platter doctrine are a bit different.

[This next section gives the history of the “Silver Platter Doctrine.” It’s not exciting reading, and is in the hidden text below.]

The IRS’ Criminal Investigation Handbook notes, “Evidence obtained by state officers under circumstances which would constitute unreasonable search and seizure under the Fourth Amendment if obtained by Federal officers is equally inadmissible in a Federal criminal trial. This repudiates the former so-called silver platter doctrine which had allowed Federal courts to admit evidence illegally obtained by state officers if there had been no collusion by Federal officials. The Federal court must decide for itself if there has been unreasonable search and seizure by state officers, even though the state court has already considered the question and irrespective of the state court’s findings.” (Admissibility of Evidence, Handbook 9.4, Chapter 9.15.4)

So let’s examine online gambling. Chuck Humphrey has concluded that online poker is technically illegal in California. His website has both a summary of his conclusions on the legality of gambling in each state and each state’s law. For example, all gambling is illegal in Tennessee and Utah. Of course, the 2003 World Series of Poker champion won his entry via online gambling and hails from Tennessee and, to my knowledge, hasn’t been prosecuted. But that doesn’t mean you won’t be, unfortunately. Until the situation is clarified (and this may take some number of years), the legality of being a professional online gambler is unknown.

On every federal tax return you must include your occupation. This is a statutory requirement. However, you do not have to incriminate yourself (the Fifth Amendment). There is nothing wrong with an online gambler (filing as a professional) calling himself a professional gambler. That’s a correct description of what he or she does. Be forewarned that if you are stupid enough to put down on your tax return that you are in an illegal occupation (e.g. “illegal drug dealer”), you can have your name forwarded by the IRS to other law enforcement.

Today the government isn’t attempting to prosecute online gamblers. However, the government might be looking to prosecute owners of online gambling sites and people who work for online gambling sites. Online gamblers are far better off declaring their gambling income on their tax returns and paying their taxes than facing fines, penalties and possible imprisonment for ignoring the law.

In Part 5 (coming next week) I’ll conclude this series by examining poker tournaments and taxes.